Expert Commentary: The OPEC Oil Rally Is Over

• Oil moved in a narrow $49-$51 range early this week before settling near $49.70 Thursday afternoon. On the bearish side, Russia and Iraq offered uncooperative sound bites regarding production cuts which added to skepticism that exporters will be able to agree on and enforce a deal creating a meaningful reduction in supply. Sustained output gains from Nigeria (currently at 1.8m bpd) and Libya (580k bpd) also helped add to congestion in the Atlantic driving freight rates higher while brent’s m1-m2 spread dropped to a contract low of more than $1 contango. Reuters reported that Saudi Arabia and other GCC members made a proposal to cut output by 4% from their recent record marks but Russia refused to participate in the effort beyond a production freeze. More positively, Bloomberg noted on Thursday that Brazil would join producers in Vienna this weekend and may be open to joining a rollback in supply.

• We continue to see a $47-$55 range for WTI heading into the November 30th OPEC meeting believing that falling crude oil and refined products stocks, the potential for a bullish OPEC announcement and managed money’s eagerness to buy dips in oil have raised the floor for the market while high levels of existing supplies, tepid demand growth and bottoming LTO production should keep rallies in check.

• This week’s DOE report was surprisingly bullish and included large draws in crude oil, gasoline and distillates continuing a seasonally abnormal bullish trend as October’s refinery turnarounds typically drive significant crude stock builds. Overall crude oil stocks have declined by 5.6m bbls over the last five weeks. During the same period in 2013, 2014 and 2015 crude oil inventories increased by 25.6m, 23m and 22m, respectively. Inventories in Cushing have also dropped by about 10m bbls since April and are below 58.5m bbls for the first time since November ’15. Going forward we see increased refiner inputs of about 1m bpd in the coming 4-6 weeks putting additional downward pressure on inventories. Overseas product stocks have also continued to tighten with ARA gasoil stocks now lower y/y by 17%, ARA fuel oil stocks are lower y/y by a whopping 41% and Singapore distillate stocks lower y/y by 5%

• Away from oil markets the EUR/USD rebounded from 1.085 to 1.094 this week while the US 2yr yield made a new 5-month high at 0.89%. Strength in the EUR/USD came despite an 8-month high in the DXY above 99.0 as Fed Fund futures implied a 78.4% chance of higher overnight rates at the conclusion of the Fed’s December 14th meeting.

Spread markets still see clearing glut late in ‘17

US producer data from last week was mixed beginning with a sharp drop in producer/merchant gross shorts from 608k contracts to 560k. The oil rig count, however, jumped to 443 and is higher by 40% since May. The rig count has not had a w/w decline in 21 weeks. US production at 8.504m bpd was its highest mark in 6 weeks and included the 2nd straight increase in production in the lower 48 states. The WTI Cal ’17 swap traded from $52-$54 this week which lead to continued producer hedging.

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In WTI the prompt m1-m2 spread moved to a five week low at -0.69 on Monday on news that a leak on Seaway (Cushing > USGC) had forced the pipeline to shut down. By Thursday afternoon the spread had recovered to -0.60 as alternate routes were used to take crude away from Cushing. In the back of Cal ’17 the WTI M17/Z17 traded as high as -0.92 on Thursday for a contango of just 15-cents per month suggesting slowly tightening market balances in the next twelve months.

Brent spreads told a similar story through Thursday with weak prompt spreads and tight spreads in the 2nd half of 2017. In the front of the curve added barrels from Nigeria (currently producing 1.8m bpd) and Libya (580k bpd) helped drive Brent Z16/F17 to a contract low of -1.08 on Thursday. Brent M17/Z17 headed in the opposite direction keeping with its bullish trend trading near -1.25. In Nigeria the NDA took credit for an attack on a Chevron owned 100k bpd export pipeline.

Option prices increase, skew still bearish

WTI F17 implied vol jumped back near 35% this week and is now unchanged over the last month. Option premiums continue to exhibit a bearish lean with 25 delta puts pricing at 38% volatility while 25 delta calls traded near 33%. In keeping with the recent bearish trend 10 delta calls priced near 2 vols below at the money options showing very little demand for upside risk heading into next month’s OPEC gathering. One of the larger options deals we’ve seen in weeks was executed on Thursday with a fund buying more than 6,000x Brent F17 $50 puts paying near $1.25.

Last week’s COT data showed a 1% increase in net length held by hedge funds in NYMEX WTI while net length in brent fell by less than 0.5%. In NYMEX WTI net length is nevertheless higher by more than 90% over the last five weeks while net length in brent has jumped by 35% over the last four weeks of reported ata. On the short side, bearish NYMEX WTI positions were but by 20% w/w while gross shorts in brent increased from 49k to 52k.

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Hedge funds have held more conviction in their view on gasoline as net length in RBOB jumped to 40k last week after speculators held a net short position in the contract as recently as August. In heating oil the net long held by funds was essentially flat at 8,400 contracts. In ETFs money managers were net buyers of the USO by $10m w/w after selling to the tune of $467m over the previous three weeks.

Bullish DOEs show larger than expected crude, product draws

• US crude inventories notched a seasonally abnormal draw of 553k bbls highlighted by a 1.3m bbl draw in Cushing• US crude production remains flat at 8.5m bpd which is above forecast• Refinery inputs bottomed at a higher level than we forecast and can be expected to help add support to the market as product stocks draw and crack margins improve• In refined products gasoline and distillate intentories fell more than expected with draws of 2m bbls and 3.3m bbls, respectively

US crude inventories fell 553k bbls w/w and are higher y/y by 4.5%. PADD II stocks fell by 1.4m bbls (+3% y/y,) PADD III stocks added 2m bbls (+6% y/y) and Cushing stocks had a weekly decline of 1.3m bbls to 58.4m bbls. US crude inventories have dropped by 44m bbls since May. Inventories in the Cushing hub have fallen by 10m bbls over the same period. As for supply, production in the lower 48 stats had a modest w/w jump and bringing overall US production slightly over 8.5m bpd.

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US refiner inputs increased for their second straight week and are higher by 180k bpd since bottoming out for turnarounds at 15.37m bpd. US refining demand is higher by 1.2% y/y over the last four weeks and utilization at 85.6% is lower y/y by slightly less than 1%. Global refining margins are mostly in line with seasonal norms with RBOB/brent near $12/bbl, WTI 321 near $14/bbl and gasoil/brent near $11.5/bbl.

Gasoline inventories fell by 2m bbls w/w and are now higher y/y by just 3% after spending most of 2016 at a substantial y/y surplus. PADD III lead the draw with a weekly decline of 2.8m bbls presumably on elevated exports to Lat Am while PADD I actually added 1m bbls. PADD IB inventories are lower y/y by about 2% after a modest weekly build. As for demand, domestic gasoline consumption jumped to 9.1m bpd w/w while exports increased to 811k bpd. Domestic consumption is lower y/y by 2% over the last four weeks.

Gasoline futures were slightly lower this week through Thursday afternoon trading in a $1.537 - $1.46 range before settling near $1.49/gl on Thursday. Monday’s high mark of $1.537 was good for a 4-month high and futures are better by about 20-cents since late August. In spread markets RBOB Z16/H17 traded near -3.60 cpg and is higher by about 1.5 cents since late July.

US distillate supplies also enjoyed a hefty w/w decline of 3.3m bbls driven by PADDs I and III. Overall inventories are now higher y/y by 7%. PADD IB stocks are higher y/y by less than 1% and PADD III stocks are lower y/y by 3% following a 1.8m bbl weekly draw. PADD II inventories are higher y/y by 20% following a 1m bbl build. On the demand side exports at 923k bpd are lower y/y by 20% over the last month while domestic demand at 4.2m bpd is lower y/y by 2%.

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Flat price heating oil was slightly lower this week but remained in a technically strong pattern finding support on the $1.54/gl level before rebounding to $1.56/gl. Spread markets still reveal some fundamental weakness in the market with Z16/H17 traded -4 cpg.